Self Invested Personal Pensions and Contracts for Difference

Mainstream pension schemes frustrate investors with their inflexibility. Self-invested pensions can include CFDs and allow savvy planning with much more control for the holder.
Not often labelled as chair-grippingly exciting investments, self-invested personal pensions (Sipps) are beginning to look increasingly attractive to sophisticated investors. While markets remain directionless, canny investors have been attracted by an option that allows them to bet on share price movements through derivatives to grow their pension pot.

The Inland Revenue has recently confirmed that CFDs (contracts for difference) are an acceptable investment for Sipps – providing they are linked to shares traded on a recognised stock exchange. But losses must not exceed the portion of the fund allocated to CFDs.

This has introduced issues that Sipp providers have had to address. As a CFD trade can result in a loss greater than the amount invested, Sipp providers need to limit the liability to the value of the assets of the pension scheme.

Providers such as Pointon York, Abbey subsidiary James Hay and AJ Bell are all now willing to allow customers to trade in CFDs. TM Sipp Services is an independent company specialising in the provision of administration, trustee and technical services for fee-based pension arrangements. Managing director Brian Talbot says: ‘We have not had demand yet, but our position is that if it’s a permitted investment then we don’t have to clear any glass ceilings to offer it. We are purely an administrator and it would be an issue for the individual’s chief adviser.’

A Sipp gives the investor many more possibilities than can normally be offered by a ‘packaged’ pension, and includes the option to invest in many different types of investments. It separates the role of the tax-efficient structure and the investment and allows investors to take personal control of the management of their pension funds.

SIPPS and CFDS offer more flexibility

Pointon York Sipp Solutions managing director Christine Hallett believes one of the major advantages of using Sipps is that, because they are written under a discretionary trust, the assets are ring-fenced and cannot be affected by any change in the fortunes of the administrator. This means that an investor’s assets are safer than many insurance company pensions, subject to the choices of underlying investments. Sipps, like personal pensions, offer tax relief on contributions at 40 % for a higher rate taxpayer. The fund will grow free of capital gains tax and 25% can be taken as a tax-free lump sum at retirement. Pensions IFAs are working with a handful of clients interested in using CFDs within Sipps to match them up with willing product providers.

The interest comes from traders who have enough knowledge to navigate their way through the market alone. For these investors, a Sipp can offer the freedom of deciding for themselves how to plan pension saving.

I-SIPP is one of the companies working with clients to match them up with Sipp providers. I-SIPP adviser Michael Fairweather says a CFD – which allows the investor to trade individual shares without putting up the full underlying contract value – offers substantial advantages over normal share trading.

CFDs work by using trades that require a nominal initial deposit. The ‘notional trading requirement’ is typically set at 10 % for equity CFDs and 7.5% for index CFDs. The basic unit of account for an individual share CFD is 1 share, subject to a minimum acceptable deal size, and valued at 1p per point.

The unit of account for an index CFD is usually the index itself – for example one FTSE 100. The value of the contract is the number of points in the index times the value per point. UK indices are valued at £10 per point. If the investor thinks the price of the underlying share or index is going to rise, he buys a contract at the offer price. If the investor thinks the price of the underlying share or index is going to fall, then he sells a contract at the bid price.

CFDs are Duty free

CFD provider Interactive Investor’s chief executive, Tomas Carruthers, thinks it is very important to reiterate that CFDs are by no means ‘new’ products. He believes they have made a natural progression to become one of today’s fastest growing UK investment vehicles.

He says: ‘It has taken five years to pass to see a more retail market open up for CFDs. In a low-yield market for the short-term investor these are fairly interesting options. Only 10% of capital is at risk, and obviously free of capital gains tax.’

The main difference between CFDs and share dealing is that because the investor is not taking delivery of the underlying shares, there is currently no requirement to pay stamp duty in the UK. However, capital gains tax is payable on both CFDs and share dealing when gains rise above an individual’s CGT allowance, which is £8,200 for the current tax year. For investors who are likely to make capital gains of more than this amount, a Sipp is particularly attractive as it provides a capital gains tax-free environment to invest in.

Another bonus is that compared with equities trading, CFD commissions on the opening and closing trade together typically amount to less than the 0.5% required for stamp duty on equities transactions in the UK.

The broker requires an initial margin as a ‘deposit’, usually 10-20 % of the investor’s underlying exposure when he places a deal, but this can be higher for risky or illiquid stocks, and also for novice investors. Although the rewards for this type of investing can be lucrative the penalties are high, and the fund set up by the investor can end up in deficit.

While Pointon York offers Sipp holders the option of using CFDs, Christine Hallett warns investors against putting all their pension nesteggs in one basket. She says: ‘One of the great features of the Sipp framework is that it allows investment in a wide range of assets, but we still see individuals enticed into low-cost arrangements that only allow specific asset classes. Take the classic stockbroker Sipp, for example. CFDs are currently the sexy choice for some but are very high risk.’

For this reason pensions IFAs like Hargreaves Lansdown remain cautious. HL pensions research manager Tom McPhail says: ‘In principle, we think it is OK for experienced investors who understand the risks; we would also be keen to ensure that adequate risk controls are in place, such as a conservative limit on the level of leveraging, and a stop-loss of no more than 100% of the investor’s investment.’

This stop-loss is exactly what IG Markets and other CFD providers will offer to some clients, and insist on for the less experienced. The facility will close the CFD once losses have reached a pre-set level. It means that a client cannot risk more funds than are available on his account. This is a huge difference from trading futures, which have open-ended liability and can result in the client owing more money than was originally invested.